20 April 2010

A smarter investment than gold

A couple of quotes from Andy Smith's Precious Thoughts commentary 19 April 2010 I like:

"the euro, still, arguably the most toxic structured product built by man"

"But this [SEC vs Goldman Sachs] is a never-ending story: The Inquisition -> Salem -> McCarthy -> Spitzer -> and here we are. It's about politics/power/control. Guilt/innocence bit players."

"Goldman were arguably the hub in the wheel [or at least the ball bearings; so this is not Lehman 2, but Lehman *2?]. Big Gov is about to put a boot in the hub. Watch what happens to the spokes: - 'Counterparty' a dirty word? We are closer to that Indian village end-game; extended families the only circle of trust, assets you can sleep nights over and on, in your mattress, the only rational investible products. The opposite of ‘synthetic’ is ‘real’."

If indeed counterparty becomes a dirty word, and people won't trust gold ETFs/GoldMoney/Perth Mint Depository or any other custodial facility, the problem is that the minting and refining industry as a whole does not have the production capacity to meet retail/mass market demand for coins and bars in my view. Look forward to high premiums and/or rationing of production. See my posts:

FUD. Fear, uncertainty, doubt. and
Why are there not enough coins?

Remembering that the ones who made money from the gold rushes were those selling picks and shovels to the prospectors, then if I am right the smartest investment will not be gold, but minters and refiners of gold.

11 April 2010

London unallocated: Fractional Fubar or Benevolent Banking?

A number of readers of my blog have asked me to comment on the 100:1 comment by Mr Christian of CPM Group in his CFTC testimony and whether London unallocated metal accounts are fractional. Well short answer is no, they are only 10:1 fractional. Do you feel much better now?

The 10:1 statement was made by Mr Christian in a April 10 interview with Jim Puplava of Financial Sense. Mr Christian is interviewed at the 26 minute mark and explains his 100:1 statement at the 36 minute mark. However, it is the comments at the 44 minute mark that are most illuminating, which I have transcribed below:

If you are a bank in the United States and you take in a deposit the office of the controller of the currency says you have a reserve requirement of 12.5% or something which means that for every dollar you take in deposits you can lend out 8 and that's how the money in banking 101 works.

Now if you're a bank in the United States and you take in gold and silver deposits not on an allocated basis but on an unallocated basis the same way you take in dollars when you put them in – when people put money into a savings account or a chequing account that's an unallocated account and the bank is allowed to lend it out. If they put the money in their safety deposit box that money belongs to the investor and the bank can't lend it, the bank can't hypothecate it, it stays there, and it means nothing to the money in circulation.

In the gold market if you put your gold and silver in a safety deposit box or an allocated account the bank can't touch it legally but if you put it in an unallocated account that is now an asset on the bank's book, they have a liability to give it to you if you ever want it back but in the meantime they can lend it out. Now if you give the bank in the United states money the law, the office of the controller of the currency says the bank can lend it out 8 times. If you give it gold and silver the office of the controller of the currency says the bank can lend it out in a “prudent fashion” and the bank has the discretion to decide what's a prudent multiple for its credit lending. Most of the banks I know, commercial banks, 8, 10, maybe 12 as a leverage factor.

AIG was not a bank, was not a commercial bank, and under the US laws non-commercial banks don't come under the law, the guidance of the office of the controller of the currency. AIG used a leverage factor of 40, so if people gave them a million ounces of gold to hold for them, they could lend out 40. I mean, I have friends who are metals traders who were looking for job years ago and, you know, they went to AIG and AIG said “we use a leverage factor of 40” and the trader is a seasoned guy and he's worked at major banks and investment banks, he said “I can't operate at that level of leverage its just too risky more me” and AIG trading said “well this is what we do”, right, so there is a loophole in our regulatory system, its doesn't really have anything to do with gold and silver per se but it allows non-banks to participate in banking activities in a way that skirts banking regulations that are designed to promote stability in the banking system.

In the interview, Mr Christian recommended that listeners go to the CPM Group website where there was a free download Bullion Banking Explained. I took him up on the offer. Below are are some extracts that fill out his statements above.

This article may help to clarify the complex world of commodity banking, in which gold, silver, and other commodities are treated as assets, collateralized and traded against. When we explain these processes to clients, we often refer to the same mechanics as they are applied to deposits, loans, and assets by commercial banks in U.S. dollars and other currencies. Banks treat their metal deposits in much the same way as they do deposits denominated in money, as the reserve asset against which they lend additional money to borrowers. ...

Many banks use factor loadings of 5 to 10 for their gold and silver, meaning that they will loan or sell 5 to 10 times as much metal as they have either purchased or committed to buy. One dealer we know uses a leverage factor of 40. (Long Term Capital Management had a leverage factor of 100 when it nearly collapsed in 1998.)

A bank does not even have to be buying gold at a particular time to be able to use it as collateral against which it can trade, sell forward, and lend gold. If a bank has gold held in an unallocated account, or a forward purchase on its books committing a producer to sell it gold later, it can use these gold assets as collateral for additional gold trades.

Is London unallocated fractional fubar or just benevolent banking? Maybe this statement by Mr Christian in a presentation to the International Cotton Advisory Council in October 2002 will help you decide:

A producer should use an advisor such as CPM Group, which is not trading against the producer. Banks and dealers have a conflict of interest between their own trading positions and the hedges they advise their clients to take.

Or maybe Recent Lessons Learned About Hedging (January 2000):

Hedgers should not rely on their trading counterparts for hedging strategies. These entities take the opposite side of the hedge transactions, have inherent conflicts of interest, and always keep their own best interests in mind, even if these are the short-term best interests and arguably not in the banks’ own long term best interests.

07 April 2010

King World News & Scotia Certificates

*Updated table on 14 Feb 2012 with 2011 figures*

In this interview, Lenny Organ (son of Harvey Organ who was at CFTC hearing) recounts how at a recent visit to the vaults of ScotiaBank they saw little physical precious metals and had to go to some trouble to get physical.

I analysed Scotia's annual report back in September 2009 after seeing a blog by ispeakofpeak on the issue. At that time the annual report revealed that Scotia only had 43% of its gold and silver certificate liabilities backed by physical metal. The table below updates that post with the most recent report (note: Scotia's financial year end is 31 Oct, figures in millions of dollars).

Ending Liabilities Assets Physical cover
Oct 11 3,931 9,249 100%
Oct 10 5,153 6,497 100%
Oct 09 3,856 5,580 100%
Oct 08 5,619 2,426 43%
Oct 07 5,986 4,046 68%
Oct 06 3,434 3,362 98%
Oct 05 2,711 2,822 100%
Oct 04 2,018 2,302 100%

It appears that the physical backing was running down from 2006 but is now back to 100%+, with $5.58 billion of physical. This contrasts with Lenny Organ statement. Either Scotia have run down a lot of physical in 6 months or it is stored elsewhere.

I do find it interesting that the gold and silver certificate liability has declined from $5.619b to $3.856b in the past year, a year when most ETFs, GoldMoney and BullionVault and Perth Mint have shown increasing amounts of metal held.

I agree with Adrian Douglas' statement in the interview that many storage providers "are very vague about what is backing their paper certificates and if they are vague I think you should not give them the benefit of the doubt". Contrast this statement from Scotia about their unallocated:

"Scotiabank gold certificates are backed by the assets of The Bank of Nova Scotia. Unallocated gold is a claim on The Bank of Nova Scotia for the ounces entitlement to a specific quantity of gold bullion."

with the Perth Mint's:

"With unallocated storage, also known as a metal account, clients purchase an interest in a pool of precious metal held by The Perth Mint. The Mint purchases an ounce of precious metal from the spot market for every unallocated ounce it sells to clients. Accordingly every unallocated ounce is 100% backed. ... The Perth Mint is not a bullion bank and does not provide project financing or bullion lending/derivative services to mining companies or other entities. It does not lend client's unallocated metal to support short selling transactions or other derivative activities. The unallocated metal is utilised solely to fund the Mint's operations."

You should always read the fine print.

05 April 2010

The Mysterious Mr Maguire's Message of Metal Manipulation

"Since criminal prosecution is only a remote threat, and since the fines and damages are generally paid by the companies, not by the individuals, the question is: what’s to keep a Sumitomo from happening again, perhaps in precious metals?" - Modern Market Manipulation by Mike Riess, International Precious Metals Institute 27th Annual Conference, 16 June 2003.

The recent statements by Mr Maguire may well prove Mr Riess right. It is well worth reading Mr Riess' presentation. It is not long and neatly identifies the factors that contributed to the copper manipulation, factors that also apply to the metals markets.

For the young'uns, "a Sumitomo" refers to the case where, as the CFTC itself found: "the principal copper trader for Sumitomo engaged in a scheme, in conjunction with an entity operating in the United States, with the intent of manipulating the price of copper. In particular, during 1995 and 1996, Sumitomo, acting through its agent or agents, established and maintained large and dominating futures positions in copper metal on the London Metals Exchange ("LME"). In the fall of 1995, Sumitomo stood for delivery on a significant percentage of its maturing futures contracts. It thereby acquired a dominant and controlling cash and futures market position, which directly and predictably caused copper prices, including prices on the United States cash and futures markets, to reach artificially high levels. ... Sumitomo intentionally exploited these artificially high prices in order to profit on the liquidation of its large portfolio of futures contracts and holdings of LME warrants."

It is because of the Sumitomo case that I am not surprised by the revelations of Mr Maguire. However, the question for me is what sort of manipulation are we talking about? It is being spun as proof of GATA's claim that the gold market is manipulated by the US Government via bullion banks in an attempt to support the dollar. While I don't begrudge GATA some PR mileage, at this time all that Mr Maguire has is potentially another "rouge trader" case, only affecting the silver markets. He is not providing any evidence about gold market manipulations or Governmental involvement.

This may come in due time if the CFTC investigate further but that does beg the question of why rely on the Government. If they are ultimately party to the manipulation, will they not make the issue go away in a backroom deal? Alternatively, if the CFTC presses on and does find something initially in the silver markets, will it just be explained away as a rogue trader who will take the fall?

In this case it may be best to fight fire with fire, in a way. GATA would achieve more, and quicker, by doing a roadshow with Mr Maguire to hedge funds, sovereign wealth funds, etc and making its case that the market has been manipulated via the surreptitious leasing and selling of central bank gold that is now all used up and hence there is a large short position that can be squeezed. The standard of proof would be much lower, just enough to convince an investor that the odds are in their favour.

Would it not be better to use brawn rather than bureaucracy? Only if you're sure the bet your pitching won't turn bad, because then your buddies will be blue (to put it mildly).